Making your own plan with IRAs
"Direct deposit is the thing that works best for me. I have $50 taken out of each paycheck for my IRA."
If your company doesn’t offer a retirement plan, you can set one up yourself. Retirement accounts that you set up on your own are known as Individual Retirement Accounts, or IRAs. IRAs come in two basic types: traditional IRAs and Roth IRAs.
- Traditional IRAs. When you invest in a traditional IRA, you may be able to deduct the amount you invest from your taxable income (assuming you aren't covered by an employer's retirement plan). This means that you pay less in taxes each year. Your IRA money is not taxed until you withdraw it in retirement. If you withdraw the money before age 59 1/2, you must pay a penalty. You may avoid paying this penalty under certain circumstances. For instance, you may be able to use the money for a portion of a home purchase if you meet specific conditions.
- Roth IRAs. With a Roth IRA, you do pay taxes on the money you invest in your account. However, you don't pay taxes when you withdraw the money in retirement. There is no penalty for withdrawing your contributions early from a Roth IRA. You do pay a penalty (and taxes) on any interest withdrawn before age 59 1/2.
Staying within contribution limits
The amount that you can contribute to your IRA varies depending on the year. In 2007, if you're under 50, you can invest as much as $4,000 per year in your IRA. This figure increases to $5,000 in 2008.
Choosing the best plan
Choosing the best IRA plan is a very individual decision. Only you can choose the plan that's right for you. If you're deciding between a traditional and a Roth IRA, consider these factors:
- Tax deductions. A traditional IRA may provide you with a tax break on your income now, whereas a Roth IRA will not. If you need the tax deduction now, a traditional IRA can help reduce your taxable income.
- Income limits. You can contribute to a traditional IRA regardless of your income level. In 2007, if you are a single tax filer, however, you can make full contributions to a Roth IRA only if your adjusted gross income is less than $99,000. If you make more than the income limit, a traditional IRA may be your better option.
- Retirement needs. You don't have to pay taxes on the money you withdraw from a Roth IRA. With a traditional IRA, you pay taxes when you take out the money. If your priority is to maximize your funds for retirement, a Roth account may help you accumulate more savings.
- Early withdrawals. Roth IRAs have no penalties for early withdrawals of the amounts that you contribute. Unless you meet certain criteria, traditional IRAs impose a 10 percent penalty on any withdrawals before age 59 1/2. If you think you'll need early access to your savings, a Roth account may provide more flexibility for withdrawals.
Getting the best of both worlds
You can hold both a traditional and a Roth IRA at the same time. If you wish to gain the benefits of both accounts, you can split your contributions over both. The contribution limit for any given year applies to both accounts, so you can still only contribute up to that maximum.
Setting up your plan
To set up an IRA, contact your financial institution. You will be required to fill out certain paperwork and to make an initial deposit. You can make contributions directly to your account.
IRAs can be established through banks, investment companies, and even discount brokers. Different companies offer different fees and initial deposit requirements. Shop around first to compare options before starting your account.
â€œDirect deposit is the thing that works best for me. I have $50 taken out of each paycheck for my IRA.â€